USD recovered yesterday after retail sales firmed up expectation for the Fed to hike interest rates by 0.25% next week. The EUR lost over the afternoon after ECB officials Visco and Knot echoed Nagel’s comments on Monday that a rate hike in September was all but guaranteed, as inflation may come down quicker than expected. Markets pricing on ECB rate hikes still suggest two more rate hikes of 0.25%, but should today's inflation numbers undershoot then expectations for further hikes could ease.
Further rate hike expectations by the Bank of England were eased yesterday, causing GBP to drop for the third consecutive day.
Inflation in Canada fell more than expected to 2.8%, but underlying inflation pressure remains in the economy with core inflation only dropping to 3.8% instead of falling to 3.6%.
* Daily move - against G10 rates at 7:30am, 19.07.23
** Indicative rates - interbank rates at 7:30am, 19.07.23
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Much to the delight of many households, inflation in the UK has fallen below 8% for the first time in a year. Headline inflation came in lower than expected at 7.9%, and more importantly core inflation fell below expectations to 6.9%. The impact in the markets has been immediate, with peak interest rate expectations dropping further to 5.8%. Only two weeks ago, the peak was priced in at 6.5%. The next Bank of England interest rate decision is on the 3rd August, with markets now rating a 0.50% rate hike only at 40%, down from a 76% probability. So what next for GBP? Well given the recent moves higher on GBP were driven by interest rate expectations, then we may well have already crossed the top of Everest. BoE member Ramsden will be speaking later this afternoon.
So next up will be final readings for June's inflation numbers from the Eurozone. Headline inflation is expected to drop to 5.5% with core expected to remain at 5.4%. The EUR has been on a very impressive run since September, mainly driven by interest rate expectations in the backdrop of poor economic growth and underperformance from China’s economy. A lower print today and July's rate hike by the ECB could be the last, and ultimately bring down the EUR particularly versus USD.
So it seems the bar was set too high by the market with respect to terminal interest rate expectations from the Bank of England. With core inflation coming in lower than expected, we’ve seen that terminal rate drop to 5.80% from a peak of 6.50%. GBP has been dropped as a result, and ultimately the question now is likely to be where next for GBP? One possibility is to look at the impact on the USD index after core inflation in the US started to drop from September. If we see below, the USD index has declined by 13.24%. Of course, this lower inflation from the UK is just one number, but should this trend continue then we could be looking at further GBP declines.
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